The U.S. real estate boom that began in 2002 has resulted in record rates of subprime lending, an expensive and risky loan product reserved for borrowers with troubled credit. Roughly 19% of all home loans in 2005 were of this type. Now, nearly 2.2 million subprime borrowers could lose their homes due to foreclosure on their loans. More disturbingly, lenders often target women and minorities for these loan products, and often unfairly according to the Consumer Federation of America (CFA). The coming wave of foreclosures will hit women, Latinos, and people of color particularly hard.
Because the interest rate associated with a subprime loan is higher (often by as much as 125 basis points, or 7% as opposed to 5%) borrowers who opt for these loans must divert a greater share of their monthly mortgage payments to paying interest, rather than paying off their house and building equity. The arrangement works out well for the lender who gets to charge more for the loan but poorly for the borrower, as many of the financial benefits of home ownership are nullified by having to pay the higher rate.
The CFA reports that women are 41% more likely than men to receive a subprime loan, even though women and men usually have similar credit ratings (in fact, women tend to have slightly higher credit scores). The report also notes that the disparity rises with income. A woman who reported more than double the median income for her area was about 50% more likely to receive a subprime loan than a man with a similar income. Minority women were the most likely to receive a subprime loan, regardless of income.
“For the African American and Latino communities, women are a key driver in achieving homeownership,” says Patrick Woodall of CFA and author of the report, “Women Are Prime Targets for Subprime Lending.” “The high rates of subprime lending to African American and Latino women-even those earning double the prevailing local income-may make it harder to sustain homeownership in these communities because of the high monthly payments on subprime loans.”
The Wall Street Journal reports that subprime lending has helped boost U.S. homeownership from 65% to 69% over the past decade. As many of these loans default, certain investors stand to make even more money through the purchase of derivative contracts.
When someone borrows money from a bank to buy a home, many of today’s banks repackage the mortgage, along with many others, into a bond, which they can then sell. Derivatives serve as insurance policies in case the bonds go bad. Investors who enter into such contracts can actually profit when loans are foreclosed upon. According to the Wall Street Journal, this growing investor group is “betting on trouble” for subprime borrowers. CNN reported that the number of foreclosures reached 109,652 in December 2006, a sharp increase from the previous year.
Offering loans at different interest rates on the basis of gender or race is illegal in the United States, thanks to the Equal Credit Opportunity Act. To combat discriminatory lending practices, CFA recommends increased enforcement of the act, increased regulatory oversight, greater competition in the subprime market, and increased accountability for lenders.
Women can protect themselves from predatory lending in two ways. First, they can get a handle on their own credit rating, of particular importance for married or once-married women who often develop bad credit through husbands’ negligent borrowing behavior. Second, they can familiarize themselves with the law, and if they suspect they’re being targeted for a subprime loan unfairly, they can confront the creditor directly, shop around for a better deal, and notify the office of their state attorney. -Patrick Tucker
Subprime Loans: Facts and Figures
* Non-U.S. investors own roughly $600 billion of the $2 trillion in subprime-backed bonds that have been issued since 2002.
* Interest-only loans comprised 18% of all U.S. subprime loans in 2005, up from virtually none in 2001.
* Roughly 3% of subprime borrowers were delinquent on their payments in 2006, meaning they were behind more than 60 days; that’s four times the number for all other types of borrowers.
* By 2008, as many as one in five subprime borrowers could be in serious financial trouble. The resulting tide of foreclosures could send homeownership in the United States down a percentage point.
Source: “As Home Owners Face Strains, Market Bets on Loan Defaults” by Mark Whitehouse, Wall Street Journal (October 30, 2006).
Originally published in THE FUTURIST, May-June 2007.